Taper! (?)

December 18, 2013

It’s ‘taper’ talk time again and here is a post that is only too happy to join the cacophony…

Dear Federal Reserve, please signal what would be at least a symbolic gesture to the market and pretend to tighten policy by beginning a tapering of long-term bond buying.  We know inflation is being promoted via ZIRP at the discount window and via money printing used for T bond and MBS asset purchases.

Now it is time to ‘taper’ and let long-term yields rise if that is what the free market wants them to do.  Given the decades-long limit at the 100 month EMA (AKA the deflationary backbone) potentially imposed by this chart, a further rise in yields is debatable anyway if all you plan to do is taper a bit.  The ‘Continuum’ in the Long Bond’s yield is at this would-be limit point after all.

30-Year Yield, Monthly

Policy has been more successful than I for one anticipated when QE3 was announced in September of 2012.  Yet nearly 1 year ago we (well, those of us who cared to look anyway) began to see the signs of an improving economy and in particular, the manufacturing sector, which was led by the canaries in the coal mine known as the Semiconductor Fab Equipment sector.

Dial forward a year and growth is now ramping at the instigation of policy to date, with ISM after ISM coming in strong.  Now let’s see what kind of legs it has.  It is time for the banks to leverage the spread you have manufactured for them and it is time for some good old fashioned inflation to hit Main Street.

BKX-SPX Ratio, Weekly

But unlike previous inflations, the current situation is actually a little tricky because on the one hand, the Banks have led the S&P500 since late 2011, which not coincidentally was when the bottoming pattern (which we noted at the time) began forming on the 30 year yield above.  Why?  Because the higher long-term yields rise while the Fed holds ZIRP, the higher the banks’ implied profit margins.

So there is some more good rationale (along with the revving economy) for a tapering regime to begin.  Sure, the stock market is hopped up on speculation and some of that may take a haircut, but it is not speculation you are promoting, right?  Noooo, of course not.

So what say we begin the transition to a vibrant economy that goes it on its own after a job well done over at Policy Central?  What could go wrong, other than maybe that black arrow on the first chart above turning red again in response to some as yet unseen liquidity event?  The banks (AKA the delivery mechanism of inflation’s cost effects AKA the leaders to the S&P 500 for the last 2 years) sure would not like declining long-term yields.

Come to think of it dear leaders, this really is tricky because what are odds that the yield is going to simply dwell below the EMA 100 indefinitely and benignly?

A break out in yields could help the banking sector deliver some money velocity into the system but at what cost?  If the backbone breaks the backbone breaks and we are in uncharted waters or at least waters not charted since the Volcker and mid-Greenspan eras.

If on the other hand yields break down despite a ‘taper’ signal, what does that tell us?  That yields have already anticipated the tapering and eventual exit of the Fed from the bond manipulation game?  Again, would yields simply dwell around current levels or take a swan dive into the next liquidity event?

Maybe the buzzword for 2014 and beyond will be a splendid interest rate ‘Dwell’ or holding pattern.  Then again, maybe it won’t.


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